What Cooked The World's Economy?

The Village Voice ^ | January 28, 2009 | James Lieber

[Windflier]

What Cooked the World's Economy?
It wasn't your overdue mortgage.
By James Lieber
published: January 28, 2009

It's 2009. You're laid off, furloughed, foreclosed on, or you know someone who is. You wonder where you'll fit into the grim new semi-socialistic post-post-industrial economy colloquially known as "this mess."

You're astonished and possibly ashamed that mutant financial instruments dreamed up in your great country have spawned worldwide misery. You can't comprehend, much less trim, the amount of bailout money parachuting into the laps of incompetents, hoarders, and miscreants. It's been a tough century so far: 9/11, Iraq, and now this. At least we have a bright new president. He'll give you a job painting a bridge. You may need it to keep body and soul together.

The basic story line so far is that we are all to blame, including homeowners who bit off more than they could chew, lenders who wrote absurd adjustable-rate mortgages, and greedy investment bankers.

Credit derivatives also figure heavily in the plot. Apologists say that these became so complicated that even Wall Street couldn't understand them and that they created "an unacceptable level of risk." Then these blowhards tell us that the bailout will pump hundreds of billions of dollars into the credit arteries and save the patient, which is the world's financial system. It will take time—maybe a year or so—but if everyone hangs in there, we'll be all right. No structural damage has been done, and all's well that ends well.

Sorry, but that's drivel. In fact, what we are living through is the worst financial scandal in history. It dwarfs 1929, Ponzi's scheme, Teapot Dome, the South Sea Bubble, tulip bulbs, you name it. Bernie Madoff? He's peanuts.

[Windflier]

This is a fascinating article, posted it seems, in an unlikely place.

If everything the author sets forth in this article is accurate, there needs to be a worldwide prosecution and subsequent imprisonment of a lot of billionaires.

[Wolfie]

Oh, come on. We all know it was Barney Frank’s fault.

[EyeGuy]

It’s been a tough century so far: 9/11, Iraq, and now this.

###

Not the main focus of the article but:

Iraq “tough”?

Iraq was a cakewalk by historical standards of warfare. Even if you include the subsequent prolonged-due-to- politically-correct-cowardice, police action, Iraq was easy compared to past episodes of human strife and difficulty.

Sheltered Manhattanites who write for the Village Voice have no idea what “tough” is.

[Grampa Dave]

This may be the best article oped on the meltdown, that I have seen.

Thanks for posting it.

http://www.villagevoice.com/content/printVersion/850296

[SE Mom]

bookmark

[AnotherUnixGeek]

So what do we do now? In 2000, the 106th Congress as its final effort passed the Commodity Futures Modernization Act (CFMA), and, disgracefully, President Clinton signed it. It opened up the bucket-shop loophole that capsized the world's economic system. With the stroke of a presidential pen, a century of valuable protection was lost.

But regulation isn't enough to stop a phenomenon called "de-supervision" that occurs when officials can't, or won't, oversee a market. It's doubtful that any agency can be relied on to control lucrative default swaps, which should be made illegal again. The bucket-shop loophole must be closed. The evil genie should go back in the bottle.

Will Obama re-criminalize these financial weapons by pushing for repeal of the CFMA? This should be a no-brainer for Obama, who, before becoming a community organizer in Chicago, worked on Wall Street, studied derivatives, and by now undoubtedly knows their destructive power.

Fascinating article, which I'm going to have to re-read a few times to fully understand (I'm no economist). But the author fingers a villain and proposes a solution - what do FReepers knowledgeable about this level of economics think?

[SirJohnBarleycorn]

Fast-forward to the early years of the Clinton administration. After an initial surge of regulatory behavior in favor of fair markets, especially in antitrust, that sort of behavior was abandoned, and free markets triumphed.

Oh, I see. The problem was that Clinton didn't exert even MORE government intrusion and control over the economy. This is left-wing propaganda.

Government intrusion and distortion of the massive housing market in this country is the ultimate source of the crisis. Packaging the bad mortgages with other mortgages and slapping a good rating on it magnified the crisis. Credit derivatives shifted the bad risk thus created to other parties, including banks whose capital was thus put at risk.

The massive housing bubble was the root cause, with numerous other contributing and magnifying factors. The housing bubble resulted primarily from the destruction of long-standing credit standards in the mortgage market for political reasons, along with the easy money Fed policy.

[Proud_texan]

There are indeed a lot of possible causes but I still have unanswered questions. Freepers are a smart lot, maybe I'll catch an answer here.

While I've not seen an exact dollar amount it appears to me that it's possible that the largest bundle of mortgage backed junk was written out of AIG's London office.

That raises the question as to why it was done out of London. Regulatory reasons or something else?

If anyone has any info on this, even if it's a false premise, I'd appreciate your info.

[1rudeboy]

This is as good a thread as any to ask (I don't feel like starting a new one): now that the dust has settled (or at least is hanging in suspension above the ground), what was the critical* failure that led to the crash? Those of us who care understand the background--the government telling lenders where to lend, etc., but I'm interested in what you think.

Richard Posner wrote a fantastic blog piece (that I didn't post because it wasn't worth the effort, and no longer can find) about how we lost our ability to assess risk, meaning that systemically, we didn't understand its magnitude. Like Donald Rumsfeld's "known knowns, known unknowns, and unknown unknowns."

I've been pondering the role of the credit-rating agencies. These were the people who were (and are) "holding themselves forth" as the experts. Though they can shrug their shoulders and say, "we effed-up," why should they be ever trusted in the future? Do you see where I'm going with this? You have the Congressional oversight function (they effed-up), you have the regulators (they effed-up), and you have the private raters (they effed-up). Shouldn't the private raters be held to a higher standard, anyway? Because we know the government is effed-up?

_____
*think shuttle rocket boosters and O-rings

[Sawdring]

Good idea. I think we need to set up a world court to try all these rich people. Or, we could let Capitalism work and let the people who are too big to fail, fail and let the auto industry that cannot compete with the Japanese and European competition fail. Once we reward those that cannot compete with economic justice we will all be better off.

[mr_hammer]

Ping

[USFRIENDINVICTORIA]

“This was the beginning of the heyday of hedge funds. Unregulated investment houses were originally based on the questionable but legal practice of short-selling—selling a financial instrument you don't own in hopes of buying it back later at a lower price. That way, you hedge your bets: You cover your investment in a company in case a company's stock price falls.”

The above paragraph is pure drivel.

First, and most obviously, hedge funds buy shorts to hedge their bets on longs. They short one thing, to hedge against losses on the other things they're long in. They don't short the same investments they're long in. That would make no sense — you'd do better by making no trades at all.

Second; the writing is totally biased, in a smarmy, propagandist style. “Questionable but legal practice” — questionable by whom? Ignorant communists?

If some large speculator (say Soros), takes out a huge short position; and then proceeds to destroy (say) a country's currency — that would be illegal (for ordinary folk). Such a practice would be equivalent to pumping a stock you're long in, in the hopes of dumping it at a higher price. Going short, without subsequent attempts at market manipulation; is no more “questionable” than going long, without attempting to manipulate the market.

It's disingenuous, at best, to conflate legal short-selling with illegal market manipulation.

[familyop]

It’s a weird publication, but the facts are cited well enough. Be sure to read the part about AIGFP in London—what we’ve seen nothing about in the many propaganda broadcasts of the past few days. ...and what is obviously being intentionally hidden.

And don’t buy anything that you don’t need for the next few years. It’s the only way that you’ll get better leadership in business and politics. Don’t vote, either, until you see enough support for a man like Duncan Hunter.

And BTW, here’s the link for the evidence in the information from the “Bank for International Settlements,” as mentioned in the article ($5—from the Bank for International Settlements, itself.

http://www.bis.org/publ/otc_hy0805.pdf

...and a quote from it.

“The over-the-counter (OTC) derivatives market showed relatively steady growth in the second half of 2007, amid the turmoil in global financial markets. Notional amounts of all categories of OTC contracts rose by 15% to $596 trillion at the end of December (Table 1), following a 24% increase in the first half of the year.1”

Facts are facts, regardless of the source, and they’re backed up with good references.

[TheConservativeParty]

$150 a barrel oil prices didn’t help. Those oil sheiks know they can stick it to us anytime they want and bring our economy to it’s knees anytime they bloody well want to. Enviroweenies and politicians keep us at peril by blocking use of our own energy. We are the Saudi Arabia of coal. We have plenty oil. When gas was 4 bucks a gallon for that long, makes it tough for some to come up with the mortgage payment they could barely afford at 2 bucks a gallon. That brought the housing industry down fast. The oil sheiks are laughing at us continually, for decades and decades. They brought the whole house of cards down by draining our national wealth into their islamic dirty hands. IMHO of course. Just sayin’.

[Windflier]

Oh, I see. The problem was that Clinton didn't exert even MORE government intrusion and control over the economy. This is left-wing propaganda.

Did you read the whole article? In my view, the author assigned blame correctly to every sector responsible for this mess.

Believe me, I was surprised to see such a balanced reading of this issue in the Village Voice. I almost didn't post it because of the source, but after reading the whole thing, I thought it was written with very little political bias.

Unfortunately, we've got an imperfect world because people are imperfect. There's a place for laws and a Sheriff in every town. There needs to be some sort of law and oversight of the banking industry by duly appointed law enforcement officials. Unfortunately, even that can be corrupted, along with whatever industry is being overseen.

I think we're now seeing the results of that.

This article is one man's reading of the issue and its root causes, but I think it sheds valuable insight on what's happened to the world economy.

[familyop]

"While I've not seen an exact dollar amount it appears to me that it's possible that the largest bundle of mortgage backed junk was written out of AIG's London office.

That raises the question as to why it was done out of London. Regulatory reasons or something else?"

Only an excerpt was posted above this thread. Follow the link for some of the answers. You'll probably be surprised.

[Humvee]

The tipping point? Bernanke raised interest rates and the scams were found out.

[familyop]

It says of the nearly $600 trillion in derivatives, that,...

"The heart of darkness was the AIG Financial Products (AIGFP) office in London, where a large proportion of the derivatives were written. AIG had placed this unit outside American borders, which meant that it would not have to abide by American insurance reserve requirements."

But there's much more behind the link.

[1rudeboy]

I think there might be a related comment upstream: I think the tipping point was $100/bbl oil. But that’s background stuff.

[WVKayaker]

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